Retail Insourcing - when the honeymoon is over

Thursday January 4th 2007

Last spring saw the announcement that Boots was to bring 100 IT jobs back in-house after renegotiating its £710 million outsourcing contract with IBM. The original ten year deal was for IBM to implement chip and PIN, new pharmacy systems and a SAP roll out.
By Ian Sampson

Far from being unsatisfied with the service from IBM, Boots has maintained that most of the work is complete half way into the full term, prompting the high street chemist to bring 100 of its 500 workers at IBM, back in-house.

The Boots story follows fairly hot on the heels of news of another 10 year IT outsourcing deal biting the dust early: Sainsburys having declared that it was ending its contract with Accenture, three years early, bringing its IT operations back in-house. On this occasion, change of IT focus was the apparent reason, the time being right to rebuild expertise back in-house.

Whatever the stated reasons, these early exits are examples on a grand scale of, first, the need for flexibility in outsourcing deals and second, to quote from a research note on the Sainsburys deal from Ovum, the possible result when you embark on a “big bang approach that made too many assumptions and carried too many risks.”

Whilst it might be overstating things to suggest a few high-profile insourcing deals demonstrate that outsourcing has had its day, there is no denying that change is in the air in the outsourcing market, and insourcing is at the core of it. Some recent research by Silicon has shown that 77 per cent of IT professionals say that insourcing is a good strategy for dealing with failed outsourcing efforts and 74 per cent of CIOs confirm that they are in favour of the practice.

Importantly, taking the Boots and Sainsburys decisions at face value, insourcing should not simply be viewed as a solution of last resort when an outsourcing deal leaves the rails - the outsourcing could be on-track but the customer, which has outsourced to transform particular business processes, reaches a point at which it is ready to bring those processes back in-house (in part, if not altogether).

The drivers behind retailers' decisions to insource, range from control (the fact that companies think that it minimises risk), flexibility (more responsive to new changes in their IT environment) to cost (many having experienced the tendency for charges to escalate under outsourcing arrangements). Furthermore, insourcing can enable the retailers' own staff to develop IT expertise and skills, safe in the knowledge that their know-how is not been used for the benefit of, possibly, competing retailers . Insourcing does, of course, also allow a retailer to shed the burden of contract management and vendor management.

But the question is whether the reward of insourcing is sufficient to stack up against the cost. In the majority of cases, insourcing is inescapably a difficult and costly process, particularly if an organisation hasn't properly provided for this eventuality at the outsourcing stage. Cost of termination aside, the retailer must ensure that it will have the capability, systems, know how - and, of course, the right people - in place to better the supplier's service once it's back in-house. So, in deciding to insource, what are the legal precautions to manage the insourcing process that retailers should take?

Leveraging the existing agreement: blind insourcing can be as disastrous as blind outsourcing. The old mantra for outsourcing is equally applicable to insourcing: don't insource your "mess for less". If your real concern is cost, you probably should not be thinking about insourcing - much better to consider re-engineering the relationship with the supplier instead. According to one recent survey, more twice as many £100m turnover businesses renegotiate outsourcing deals rather than insource . Retailers would, after all, do well to remember the reasons why they elected to outsource in the first place - poor purchasing power, insufficient technological knowledge, poor change management anyone? It makes much more sense to have a decent benchmarking procedure mid-term (something that is missing from too many outsourcing contracts), allowing for sensible renegotiation with you provider, than simply to think in terms of addressing every dissatisfaction through insourcing.

People issues: Outsourcing transactions often result in the transfer of retailer IT staff to work for the supplier under the TUPE legislation. The same will happen in reverse: are you aware of which employees of your service provider will come over to you when you insource? Will it include employees that you were happy to 'lose' to the supplier when outsourcing in the first place? Has the team been bulked up by the supplier so that you will actually assume responsibility for a greater number than originally went over to the supplier? And do those extra people have the skills, experience and, importantly, cultural values, that you are seeking? Will these people have developed knowledge that, instead of coming back to you is now owned by your service provider under the terms of the relevant employment contracts? The answers to these questions may give rise to a hidden cost in terms of employment and IP costs. And, ignoring hard cash just for a moment, what will be the psychological impact on these staff? They may not be particularly keen on the idea of returning to work for the retailer that sent them somewhere else in the first place.

Complex services: insourcing complex processes high in the value-chain - such as value-add services and service management - will need careful analysis as to whether your organisation has the in-house capability to provide these services effectively, notwithstanding the particular skills of the individuals that might come across. A gradual, planned handing-back will be crucial to ensure the management of the insourcing process whilst safeguarding quality.

Multi-sourcing: Insourcing, as mentioned earlier, can be a retrograde step, making a mockery of the decision to outsource in the first place. Unless there really has been a successful transformation a la Boots' statement, it is little more than something expensive and complicated to implement in order to put you back in the position you were in years before. Not really a compelling IT strategy. Other avenues and scenarios should always be explored at the outset: it is unsurprising to see many customers choosing to spread the initial outsourcing risk by multi-sourcing - smaller, shorter-term deals with various vendors, rather than the 'big basket' approach of one long-term commitment. This spreading of risk inevitable carries its own risks - not least managing a variety of providers and avoiding having important action disappearing into the crevasses between the different agreements. It does, however, arguably leave insourcing as a more viable bite-sized option than is the case under the single supplier structure.

Flexibility: Few organisations have any real idea how their business model will change over the course of a ten year outsourcing deal. This is, indeed, often a driver for IT outsourcing in its own right, placing the handling of technological advances with an expert organisation better able to gauge the winds of change. That is a compelling reason for outsourcing but it is not an excuse to stop thinking about other changes in your core business, which will also change over those ten years. Changes to your business model may, of course, make an outsource model less attractive - volumes, the importance of what is being outsourced, the availability of expertise elsewhere, consolidation of your own industry (and the fact that you may merge with someone that has a much better approach) all dictate that the outsourcing agreement gives the retailer the ability to operate flexibly without being sanctioned financially. The supplier will of course have a different perspective: flexibility is fine so long as the supplier is not paying for well-trained professionals who are not fully being deployed. But this is something that simply needs to be addressed directly by negotiation on the provisions covering contract management, change control, fees and termination.

Mid-term reviews: continuous review is essential in ensuring that organisations are able to reorganise the deal mid-term, making provision for insourcing, or re-scoping if a mid-term review indicates that course. Such review might, to minimise cost and disruption, be tied in with a benchmarking exercise (which could cover a range of matters from cost to technological advances to whether, years into a contract, the original service levels are still appropriate).

There is little doubt, from the evidence of various surveys that insourcing - or at least the contemplation of insourcing as a solution - is on the rise. This seems particularly to be the case in the retail sector. This is occurring predominantly, we would suggest, through retailers having their outsourcing fingers burned - the benefits too often do not stack up as solidly as had been the promise. But the end of the honeymoon period between retailer and supplier should not necessarily be the death knell for the entire outsourcing project - retailers have to be objective and carefully decide whether transferring altogether to a new supplier, breaking work streams into a multi-sourcing model or even simply re-engineering the whole relationship with the incumbent supplier is, actually, more appropriate. Two wrong decisions do not make a right decision, and insourcing is, after all, just one of many options.

Ian Sampson is a partner at the technology and outsourcing group at Addleshaw Goddard